Intermediate Accounting, 11th ed.
Kieso, Weygandt, and Warfield
Chapter 19: Accounting for Income
Taxes
Prepared by
Jep Robertson and Renae Clark
New Mexico State University
Chapter 19: Accounting for Income
Taxes
After studying this chapter, you should
be able to:
1. Identify differences between pretax
financial income and taxable income.
2. Describe a temporary difference that
results in future taxable amounts.
3. Describe a temporary difference that
results in future deductible amounts.
4. Explain the purpose of a deferred tax
asset valuation allowance.
Chapter 19: Accounting for Income
Taxes
5. Describe the presentation of income
tax expense in the the income
statement.
6. Describe various temporary and
permanent differences.
7. Explain the effect of various tax rates
and tax rate changes on deferred
income taxes.
8. Apply accounting procedures for a loss
carryback and a loss carryforward.
Chapter 19: Accounting for Income
Taxes
9. Describe the presentation of deferred
income taxes in financial statements.
10.Indicate the basic principles of the
asset-liability method.
Fundamental Differences between
Financial and Tax Reporting
Deferred Taxes: Basics
• Deferred taxes arise when income tax
•
•
•
•
expense differs from income tax liability.
The tax expense is determined under GAAP.
The income tax liability is determined under
the Internal Revenue Code.
Some of these differences are temporary and
reverse over time.
Others are permanent and do not reverse.
Temporary Differences: Examples
• Revenues and gains, recognized in financial
income, are later taxed for income tax
purposes.
• Expenses and losses, recognized in financial
income, are later deducted for income tax
purposes.
• Revenues and gains are taxed for income tax
purposes before they are recognized in
financial income.
• Expenses and losses are deducted for income
tax purposes before they are recognized in
financial income.
Summary of Temporary
Differences
When recorded
Transaction
in books
When recorded
on tax return
Deferred
tax effect
Rev or Gain
Earlier
Later
Liability
Rev or Gain
Later
Earlier
Asset
Exp or Loss
Earlier
Later
Asset
Exp or Loss
Later
Earlier
Liability
Permanent Differences: Examples
•
•
•
Items, recognized for financial
accounting purposes, but not for
income tax purposes:
interest income received on tax
exempt securities
fines and expenses resulting from
violations of law
Premiums paid for life insurance on key
officers/employees
Permanent Differences: Examples
•
•
Items, recognized for tax purposes, but
not for financial accounting purposes:
the dividends received deduction
under the Code
percentage depletion of natural
resources in excess of their cost
Summary of Permanent
Differences
Sources of Permanent Differences
Some items
are recorded
in Books
Other items
are NEVER
recorded in books
but NEVER
on tax return
but recorded
on tax return
No deferred tax effects
for permanent differences
Deferred Tax Asset & Deferred
Tax Liability: Sources
Deferred taxes may be a:
• Deferred tax liability, or
• Deferred tax asset
Deferred tax liability arises due to
net taxable amounts in the future.
Deferred tax asset arises due to net
deductible amounts in the future.
Recording a Valuation Allowance
for Doubtful Deferred Tax Assets
If the deferred tax asset appears
doubtful, a Valuation Allowance account
is needed.
Journal entry:
Income Tax Expense
$$
Allowance to Reduce
Deferred Tax Asset to
Expected Realizable Value
$$
The entry records a potential future tax
benefit that is not expected to be realized in
the future.
Deferred Taxes: Applying Tax
Rates
• Basic Rule: Apply the yearly tax rate to
calculate deferred tax effects.
• If future tax rates change: use the enacted
tax rate expected to apply in the future year.
• If new rates are not yet enacted into law for
future years, the current rate should be used.
• The appropriate enacted rate for a year is the
average tax rate [based on graduated tax
brackets].
Revision of Future Tax Rates
• When a change in tax rate is enacted,
its effect should be recorded
immediately.
• The effect is reported as an
adjustment to tax expense in the
period of change.
• Changes in tax rates are treated just
like any other change in estimate,
prospectively.
Revision of Future Tax Rates:
Example
End of 2002, corporate tax rate is changed
from 40% to 35%.
The new rate is effective January 1, 2004.
The deferred tax account (1/1/2002) is as
follows:
Excess tax depreciation:
$3 million
Deferred tax liability:
$1.2 million
Related taxable amounts are expected to
occur equally over 2003, 2004, and 2005.
Provide the journal entry to reflect the
change.
Revision of Future Tax Rates:
Example
The deferred tax liability end of 2005 is as follows:
2003
2004
2005
Future tax inc $1,000,000 1,000,000 1,000,000
Tax rate
40%
35%
35%
Deferred tax
$400,000
350,000
350,000
liability
Entry:
Deferred Tax Liability
$100,000
Income Tax Expense
$100,000*
*$1,200,000 – $1,100,000
Balance Sheet Presentation
Balance Sheet Presentation:
• The deferred tax classification relates to its
underlying asset or liability.
• Classify the deferred tax amounts as current
or non-current.
• Sum the various deferred tax assets and
liabilities classified as current.
• Sum the various deferred tax assets and
liabilities classified as non-current.
Balance Sheet Presentation
Balance Sheet Presentation:
• Sum the various deferred tax assets and
liabilities classified as current:
• If net result is an asset, report as current asset
• If net result is a liability, report as current liability
• Sum the various deferred tax assets and
liabilities classified as non-current:
• If net result is an asset, report as long-term asset
• If net result is a liability, report as long-term
liability
Income Statement Presentation
Income tax expense, is allocated to:
•
•
•
•
Continuing operations
Discontinued operations
Extraordinary items
Cumulative effect of an accounting change,
and
• Prior period adjustments
Disclose other significant components,
such as:
• current tax expense,
• deferred tax expense/benefit, etc.
Net Operating Losses [NOLs]:
Basic Terminology
Net operating loss is a tax terminology.
A net operating loss occurs when tax
deductions for a year exceed taxable
revenues.
Net loss or operating loss is a financial
accounting term.
NOL can be derived from net loss, but
these two amounts must be kept
separately.
NOLs: Rules of Application
•
•
•
NOL for each tax year is computed.
The NOL of one year can be applied to
offset taxable income of other years,
possibly resulting in tax refunds
NOLs can be:
carried back 2 years and carried forward 20
years (carryback option), or carried forward
20 years (carryforward only)
Net Operating Loss: Carryback
Rules
• If NOLs are carried back 2 years and carried
forward 20 years:
• NOL is applied to the earlier of the 2-year
period, then to the immediately preceding
year, etc.
• Remaining NOLs are applied to the following
20-year period.
• Any tax refunds are reported in the year of
the original net operating loss.
NOL Carryback Rules
Tax years
2001
2002
2003
2004
2005
2006
next
Apply first
NOL
2004
Loss carryforward
20 years forward
Expect
tax refund
Record all
here
tax effects here
Expect
tax
shield
here
2007 2024
NOL Carryforward Rules
Tax years
2001 2002
2003
2004
NOL
2004
Forgo 2
year rule
2053
2006
2007
Loss carryforward
20 years forward
Record all
tax effects here
Expect
tax
shield
here
2024
Basic Principles of Asset-Liability
Method
• A current tax liability or asset is recognized for
the estimated taxes payable or refundable on the
tax return for current year.
• A deferred tax liability or asset is recognized for
the estimated future tax effects attributable to
temporary differences and carryforwards.
• The measurement of current and deferred tax
liabilities and assets is based on provisions of
enacted tax law, effects of future changes in tax
law or rates are not anticipated.
• The measurement of deferred tax assets is
reduced, if necessary, by the amount of any tax
benefits that are not expected to be realized.
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